ECB Meets Amidst Tough Talk on Trade

Today, the ECB starts its two-day monetary policy meeting. The meeting comes at a difficult time in the global trade and economic environment.

The most important part of the global economy today is about the looming trade war. Last week, after a meeting between steel and aluminum companies, Donald Trump announced that the country would impose a 25% tariff on all steel and aluminum imports.

This unexpected move roiled over the global financial markets, which were previously hoping that Trump would not follow through what he had promised during the campaign.

Yesterday, in response, the European Union released a long list of American products that they would impose tariffs on. The products ranged from fashion, to wine, to motorbikes.

In response, during a press conference, Trump promised to retaliate if the country is targeted by the European Union. To a large extent, he has a point. While the US has a service trade surplus with the EU, its deficit on goods is larger. For example, the US exports goods worth $270 billion to the EU. It imports goods worth $416 billion creating a trade deficit of $146 billion. Therefore, if both countries were to apply a 25% on their goods, the US would get $37 billion from these tariffs.

However, in an era when the Western countries are trying to contain China, a trade war will not be beneficial to the European economies. Last year, the EU’s economy grew faster than the US, even with the Brexit cloud hanging over it. France’s President Macron further aided the growth in the economies. In response, the Euro continued its upward surge against other currencies as shown below.

Today, the European Union will release its Q4 GDP numbers. Markets expect that the European economy advanced by 0.6% in the quarter and at an annualized rate of 2.7%. All these are unchanged from the previous readings.

Tomorrow, the markets expect that the ECB will leave interest rates unchanged at 0.00% and the deposit facility rate to remain at -0.4%. This will happen since the ECB has already issued a forward guidance on that.

The key takeaway for tomorrow will be about the future of stimulus as the world braces for a trade war. Markets will want to hear from Draghi whether the prospects of a trade war are rising. Will this new paradigm change the thinking of the ECB?

As you recall, the ECB has issued a forward guidance where they plan to end the easy money policy in September this year. They expect that the theoretical Phillips Curve model will work. In this theory, the rate of inflation tends to rise when the unemployment rate falls. As the chart below shows, the Eurozone unemployment rate has fallen from a high of 12.2% in 2014 to the current low of 8.6%.

At the same time, the EU’s inflation rate has managed to move from the negative territory in 2015, to the current 1.3%. Of course, this is lower than the ECB’s target of 2.0% but Draghi expects inflation rate to rise in sync with what other developed countries are doing.